A Weak US Dollar: How Does that Impact You?

Thu Sep 27 16:24:00 GMT 2007

by
Kathy Lien

At a time when the US housing market is
contracting, the job market is deteriorating and consumer spending is at risk,
the US economy needs a weaker
dollar.This is the primary reason
why we do not expect the US government and the Federal Reserve
to stand in the way of further dollar weakness.

Benefits of a Weaker
Dollar

1) Increased Exports –
One of the biggest
reasons why a weaker dollar will help the US economy is
because it increases the competitiveness of US goods.It boosts foreign demand while keeping
US consumer demand domestic.Over the medium term, this benefits the
sales of US corporations which will eventually translate into more jobs and
consumer spending.It also helps to
reduce the trade deficit, one of the most criticized aspects of the
US economy.

2) Foreign Investment –
There are three
different ways that foreign investment can help the US economy and
the US dollar.Over the past few
years, foreigners have been big buyers of US real
estate.According to a study by the
National Association of Realtors, about one in five American real estate agents
sold a second home in the year ending April 2007 to a foreign buyer.A third of these buyers come from
Europe, a quarter from Asia and 16 percent from Latin
America.As the US
dollar continues to fall in lockstep with house prices, foreign buyers could
provide the support that the US housing market needs to avoid a
major crash.The second support
would be in the form of value hunting in the US equity
markets.If the dollar continues to
fall, foreign investors may begin to load up on companies with sound
fundamentals that are also less vulnerable to a US economic
slowdown. Both of these factors are contingent upon the US dollar showing signs
of stabilization.Foreign investors
will only swoop in with size when they believe that dollar weakness is nearing
an end.The third factor is less
contingent upon the outlook for the US dollar.A weaker dollar also makes US
corporations more attractive buyout targets.Sovereign wealth funds of countries like
China and Dubai are flush with cash
and are on the lookout for good investment opportunities.

3) Increased Tourism –
Tourism represents a
big part of the US economy. It supports employment
for over 5.4 million workers and generates over $550 billion in annual
revenue.Canadians represent the
biggest group of travelers into the US.We expect their share to rise even
further now that the Canadian dollar is trading at parity with the US
dollar.In the beginning of this
year, a USD$250 hotel room cost CAD$295, now it only costs CAD$250, which
represent savings of over 15 percent. Although the savings for Europeans are
not as large, they too will see anywhere between a 5 to 10 percent discount in
travel costs.More tourism is
always good for an economy.

Disadvantages of a Weaker
Dollar

1) Higher Costs for Foreign Goods –
The most immediate
disadvantage of a weaker dollar is the increased costs for foreign goods. With a trade deficit of $59.2 billion, US
consumers import far more than they export.The number one country that the
US imports from is
Canada, which is why the recent
strength of the Canadian dollar is so important. Canadian drugs for example may
not be as much of a bargain as they use to be.The same is true for European handbags
and other luxury items.

2) Tighter Monetary Policy –
Higher costs for
foreign goods imports inflation which is why a weaker currency in general is
inflationary.With oil prices
hovering around $80 a barrel and the dollar falling through the floor, inflation
is sure to pick up in the coming months.Martin Wolf of the Financial Times makes a fantastic point when he said
that “The resolutionof each crisis lays the seeds of the next.”
In order to get out of a crisis, the Federal Reserve will usually lower
interest rates aggressively.We saw
this after the Asian and Russian crises of 1997 and 1998.This eventually led to bubbles in the
financial market, forcing the Fed to hike interest rates.Although inflation is not a huge problem
at the moment, the threat of inflationary pressures could prevent the Fed from
lowering rates as much as they would have otherwise wanted or needed.

3) Foreign Travel Becomes More
Expensive – From a
consumer level, the weakness of the US dollar makes foreign travel more
expensive, particularly to countries like Europe and Australia.Since the beginning of the year, the
Australian dollar has appreciated more than 10 percent against the US dollar.
Because of nothing other than currency fluctuations, travel to
Australia has become 10 percent more
expensive.The same is true for
travel to Europe except for the fact that the
move is smaller on a percentage basis.

Can the US Dollar Fall
Further?

The answer is yes.A trend in the currency market can last
far longer than many people would otherwise expect. We have seen one way
directional moves last for months and in some cases, even years.Interest rate outlooks play a major role
in the future direction of currencies so with the market pricing in another
125bp of easing by the end of next year, the US dollar could easily fall to 1.50
against the Euro.This is
especially true if the ECB remains nonchalant about the Euro’s move.At some point, the benefits of a weaker
dollar such as increased exports and foreign investment will help to turn the
US economy around, at which point the
dollar will begin to rise once again.

What Does This Mean for Your
Investments?

Regardless of whether you are
actively involved in the currency market or monitor it at all, the value of the
US dollar or currencies does matter.Companies that do a lot of foreign sales will benefit the most because
their foreign currency revenue will be higher when repatriated not because they
sold more goods, but because their earnings from currency conversion will be
larger.The industries with the
greatest foreign sales exposure are energy, technology and consumer
staples.Companies that
produce commodities usually also benefit from dollar weakness while the
companies that will be hurt the most are big importers.If you have a view on where the US
dollar is headed or want to hedge against some of your stock market exposure,
the purest way to do so would be through trading or investing in the US dollar
directly in the currency market.

By Kathy Lien, Chief Strategist
of DailyFX.com

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.